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Warren Buffett's Favorite Dow Stocks

A look at the Oracle's top Dow picks.

Warren Buffett is the most celebrated investor of our time. The Oracle has achieved 19.8% compound annual growth in per-share book value for Berkshire Hathaway since its 1965 inception, or about 10.6% better than the S&P 500 has managed over the same period.

And Buffett usually does it by buying up boring name-brand companies and holding them for a long time. It's hardly the sort of strategy many get excited about, but it works. So where does Buffett find his favorite holdings? Right in plain sight: The Dow Jones Industrial Average(INDEX: ^DJI).

Some may call the Dow limited, but of the 14 common-stock investments with a market value of more than $1 billion that Berkshire Hathaway(NYSE: BRK-B) held at the end of 2011, seven of them were Dow components. That means Buffett owns one out of every four stocks on the Dow, the sleepy index many investors avoid because they think the companies are too big to meaningfully reward shareholders. I'd say they're wrong.

Here are Berkshire's seven Dow positions ranked by market value.

Company

% of Company Owned

Market Value (Billions)

Coca-Cola(NYSE: KO)

9%

$14.0

IBM(NYSE: IBM)

6%

$11.8

American Express

13%

$7.2

Procter & Gamble(NYSE: PG)

3%

$4.8

Kraft

5%

$3.0

Wal-Mart

1%

$2.3

Johnson & Johnson

1%

$2.1

Source: S&P Capital IQ.

It's no secret that Buffett loves his Coca-Cola, and it shows in these holdings. The manufacturer and distributor of the world's top soda garners a whopping $14 billion commitment from the Oracle, more than any other Dow component. Berkshire owns just shy of 9% of the company and is its largest shareholder. At current levels, Berkshire collects about $410 million from Coke every year in dividends alone. With payments like that and a moat to protect them, it's easy to see why Buffett likes the company so much.

IBM is Buffett's most recent Dow component, and already he's committed more money to it than five others. In his letter, Buffett writes that he "was late to the IBM party" and admits that he's been reading the company's letter for 50 years. Better late than never, as IBM buys back shares at a steady clip. What's more is that in 2010, then-IBM President and CEO Sam Palmisano boldly declared that this company "will double profits by 2015." That would be $20 per share. At $13 per share in EPS right now, IBM is well on its way.

American Express is a longtime Buffett holding whose closed-loop credit card model allows it to capture more value in the credit card cycle than open-loop competitors such as Visa do. It's a strong, defensive company for the long-term investor.

Procter & Gamble tops many investors' lists as a "must own." The consumer-goods juggernaut has 22 billion-dollar brands and outmaneuvers competitors to regularly occupy the top one or two spots in most product categories. With its 3.2% yield and a history of raising dividends that predates many of its shareholders, it's easy to see why P&G is a Buffett top Dow stock.

Kraft and Johnson & Johnson are two of the more interesting holdings on this list. I've been a little down on Kraft recently and am eager to see whether its spinoff creates as much value as the company is advertising. Kraft could also lose its status as a dividend aristocrat in the process, much as Altria did in 2008, when it spun off Philip Morris. I'm in hurry-up-and-wait mode on this one. Buffett recently reduced his holding in Johnson & Johnson because of concerns over quality-control issues, and he reduced his stake in Kraft as well.

Even better stocksThere you have it: Buffett's seven top Dow stocks -- big, boring, dividend-paying American icons. Of course, even with Buffett's investing acumen, the Dow can feel like a short aisle to shop in. That's why we looked elsewhere to find The Motley Fool's Top Stock for 2012. Our top stock is an emerging-market retailer hand picked by our chief investment officer as a company that will rule 2012. You can uncover this pick today and download your copy of our special free report. Fool on!